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Bank ups interest rates

11.07.2007

The Bank of England has moved to increase interest rates for the fifth time in a year to 5.75 per cent this week.

It had been widely expected that there would be an increase this month, after the vote at the last meeting of the monetary policy committee (MPC) was split five to four against an increase with governor Mervyn King opting for a rise.

The MPC noted that inflation has been falling back, with lower gas and electricity prices, but felt that pricing pressures elsewhere meant a rate rise was necessary.

In a statement, the body noted: "Lower gas and electricity prices mean that CPI inflation is likely to continue to fall back to around the two per cent target in the course of this year. Although pay pressures remain muted, the margin of spare capacity in businesses appears limited and most indicators of pricing pressure remain elevated."

It added that the balance of risks for inflation in the medium term was for a rise so an interest rate increase was necessary.

Trevor Williams, chief economist, Lloyds TSB Corporate Markets, claimed the decision to raise interest must have been a tight vote.

"Some MPC members probably wanted to hold out for more proof that another rate hike was really necessary, but there are others who believe the MPC has been too slow to raise rates. On balance they've made the right move in opting for a rise now," he said.

"It's true that the economy is showing some tentative signs of a slowdown. But at the same time, house prices surged again last month, money supply growth continues to accelerate and the services sector remains robust."

He went on to say that some members of the MPC may be pushing for a rate rise under the belief that the longer the delay, the higher rates will have to go before peaking.

"The financial markets are looking for at least one further rise - but it could be spring next year before we see another move, and that move is more likely to be down than up."

Quentin Fitzsimmons, head of government bonds at Threadneedle Investments, also feels that rates could well now peak.

"The interesting question is whether 5.75 per cent - the highest base rate we have seen in the UK in more than six years - represents the top of the cycle. We think it should, as we still have the lagged effects of the previous hikes to come and many consumers are already enduring falling real incomes," he said.

"With the housing market slowing in most of the country and trading evidence suggesting sluggish conditions in the retail sector, our model is forecasting a slowdown in growth in the second half of the year."

However, Mr Fitzsimmons added that with the MPC's main focus inflation and not growth, a rate rise to six per cent could not be ruled out.

Paul Niven, head of asset allocation at F&C, explained that important data to come in the next month that will dictate if rates will rise again will be the August Inflation Report, showing where the MPC feels inflation is heading, and data releases on consumer borrowing and spending patterns

He said: "While markets may be too bearish over the longer term level of UK rates, clearer signs of a moderation in economic activity are required to see sustained respite from the bank's path of higher rates."

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